Monetary Policies: Bank rates explained in lay terms

This post is a follow up of the tools for carrying out monetary policies which we have been discussing….Check previous posts for more details.

    Bank rates are the rate of interest at which other banks borrow from the CBN or from each other. For instance, if Access bank borrows money from the Central Bank, they will have to pay back with interest. The rate of interest that CBN will charge Access bank for that money borrowed is called Bank rate. Also, if UBA borrows money from Fidelity bank, they will also have to pay back with interest, the rate of interest that Fidelity bank will charge UBA is also called Bank rate.

I know you are wondering “WHY A BANK THAT HAVE EXCESS MONEY WITH THEM SHOULD CONSIDER BORROWING MONEY FROM ANOTHER BANK”?

Remember that in the post about liquidity ratio, (Liquidity ratio explained in lay terms) it is not all the money deposited in the bank that the bank keeps in form of cash. It is only a percentage that they keep as cash. A case may arise when a bank does not have enough cash to give to customers who wish to withdraw their money. Or a case when a customer wants to collect a loan of huge amount of money that cash available in the bank is not enough to carry. The fastest thing for them to do in order to satisfy their customers is to rush over to the nearest bank or the nearest CBN branch and borrow money (cash) which they will have to pay back with interest to the bank they borrowed from. This interest rate is called bank rate.

If the bank rate is LOW, banks will find it easy to borrow money from the CBN and other banks and so they will be more willing to give money to their customers and to individuals and companies that wish to collect loans from them, Thus increasing the money in circulation. This is an EXPANSIONARY POLICY.

If the bank rate is HIGH, banks will find it difficult to borrow from the CBN and other banks. In this case, the Banks will not be so eager to give out cash or loans, thus reducing the amount of money in circulation. This is a CONTRACTIONARY POLICY.

After the CBN monetary policy meeting held in March, the bank rate of the CBN was placed at 12% from the previous 11% this means that if any bank in Nigeria borrows from the CBN or from any other bank in Nigeria, they will pay an interest of 12% of the money they borrowed every month until pay back the money they borrowed. This percentage of Bank rate is relatively high which is pointing to the fact that Nigeria has adopted a CONTRACTIONARY MONETARY POLICY for this year, aimed at reducing the amount of money in circulation.

NB: if the bank rate fixed by the CBN is low, the bank will be willing to give out money by lowering the interest rate they charge their customers who wish to borrow money. But if the CBN bank rate is HIGH, the banks will not be willing to give out money by increasing the interest rate they charge their customers who wish to borrow money. In essence, it is the bank rate that determines the rate of interest commercial banks charge their customers that wish to collect loans or overdraft or use credit cards. Next up MORAL SUASION. Stay posted. Comment below.